What to do with a cash gift?

by iam1percent on November 15, 2012 · 9 comments

Every year around the March timeframe, I’m do for my annual bonus. It comes through as a lump sum in cash. Historically, I have used it to pay off debts, but today I want to walk through my thought process for what you should do if you were to come across a cash gift. Often times this happens as a result of a bonus, inheritance, pension, or a nice gesture from a close friend/family member. Here is my thought process in order:

Can I use the money to pay off non-tax deductible debt?

There are many tax deductions that are available to many Americans, but are not available to high income individuals. That said, we have one debt that is not tax-deductible. Our rental properties have mortgages that are typically tax-deductible, but for high income earners, the tax deduction for mortgage interest disappears. This will likely be my first choice.

Can I use the money to pay off a high interest debt?

If I did not have non-tax deductible debt, I would look at all other debt and pay off the highest interest rate debt. The way to look at this is to think that you are actually earning the interest rate that you would have otherwise paid on that debt. For instance, if you have a $10,000 car loan at 5%, then paying off that loan would have earned you 5%.

Can I invest the money elsewhere that will earn me more than my highest interest rate loan?

Depending on the interest rate environment, I may forgo paying off a high interest rate loan if I could earn more in another investment or saving vehicle. In a low-interest rate environment, like the one we are in now, it is more difficult to find higher interest rate vehicles. In a high interest rate environment, it is easier to find these types of vehicles (i.e. CDs, money market, savings accounts).

Can I give it away to charity?

We give about 10% of our gross income to charity, including the church, which does a lot to help people less fortunate in our community. Sometimes, it makes sense to look into your own personal finances, your own heart, and give the money to people who need it.

Any other ideas on what to do with a lump sum cash payment/gift?

 

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{ 9 comments… read them below or add one }

Mrs. Pop @ Planting Our Pennies November 15, 2012 at 1:53 pm

Don’t forget to not have a heart attack when you see how much lower the actual bonus is once income taxes are taken out! =)
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iam1percent November 15, 2012 at 10:04 pm

This is not my first bonus, so i’m painfully aware of the tax hit :(
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The White Coat Investor November 15, 2012 at 1:54 pm

I often use lump sums to invest. My only “recurring” investment is my 401K/profit sharing contribution. My other investments I do as a lump sum every year- 529s, defined benefit plan, backdoor Roth IRAs, HSA etc. If I was saving enough to use a taxable account, that’s easy to lump sum too.

I’ve written previously about thought process of deciding whether to pay down loans or invest. It mostly comes down to the after-tax rate and the possible tax advantages of the investment. For example, I’d pay down a 4% loan instead of investing in a taxable account, but I might hold an 8% loan in order to max out a Roth IRA. Here’s the link: http://whitecoatinvestor.com/student-loans-vs-investing/
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JimL November 16, 2012 at 9:29 am

I have used my past bonus payments to pay off my mortgage and am now totally debt free. I have now been using my bonuses for future college expenses. With my bonus this February, I will have have almost everything fully funded in that category. My retirement accounts are in good shape and I have a nice pension, but I will probably used future bonus payments to accelerate the early retirement date.

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so November 16, 2012 at 4:31 pm

Not sure what you mean about mortgage interest not being deductible on rental properties.

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iam1percent November 19, 2012 at 9:41 am

From Turbotax website:

But this exception phases out as your income rises. If you have modified Adjusted Gross Income over $100,000, the $25,000 rental real estate exception decreases by $0.50 for every dollar over $100,000. The exception is completely phased out when your modified adjusted gross income reaches $150,000.

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so November 20, 2012 at 11:14 am

Oh, right. The loss is still deductible against business income, though, and you can carry forward the loss to offset other gains.

Paying down rental mortgages is a good use of a bonus; if you can recast or do a cash-in refinance, it can also increase cash flow nicely.

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Ornella @ Moneylicious November 19, 2012 at 8:54 pm

Often I consider additional lump-sum/gifts money as windfall money. Typically, I continue to make financial decision as though I never received the money. If I do decide to use the money for anything, it’s typically for investing. Some will be placed in cash. I review my financial goals and see where I stand to make an informed decision.
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mark November 27, 2012 at 6:55 pm

Great read, I also look to pay down non-deductible debt, that is if I have any money left after deferring most of it to either my 401k or IRA. I think spending it on something you really want should be an option too. People work too hard these days, they deserve a treat every now and then :)
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